Uptake and evaluation of innovative insurance embedded credit for promoting resilience and livelihoods for smallholder in Kenya

3ie evidence programme:  Agricultural Insurance Evidence Programme
Author(s): Apurba Shee, Liangzhi You
Institutional affiliation(s): University of Greenwich, International Food Policy Research Institute
Grant-holding institution: International Food Policy Research Institute
Main implementing agency: International Food Policy Research Institute
Sex disaggregation: Yes
Gender analysis: Yes
Equity focus: Yes
Study type: Formative evaluation

Context

Machakos County is a semi-arid and hilly terrain area in Eastern province of Kenya. It receives very low annual rainfall of around 700 mm per year with average rainfall in long and short rain seasons being 315 and 266 mm, respectively (Situation Analysis-GOK 2014). Due to this semi-arid climate, agriculture is practiced by smallholder farmers with maize being the main food crop.

Financial institutions in rural Kenya often face challenges in providing credit to smallholder farmers who either do not have adequate collateral or are unwilling to bear the risk of losing collateral if they are unable to repay the loan. Crop insurance provides an effective tool to improve farmers’ ability to repay such loans, but crop insurance coverage is almost universally low due to myriad reasons including basis risk, liquidity constraints, lack of trust, and ambiguity aversion. With Risk-Contingent Credit (RCC), insurance payments if triggered, are applied to the underlying debt obligation, thereby reducing default risk. Because the insurance component of RCC substitutes for collateral, it is in theory more inclusive than conventional credit products.

Intervention design

The intervention is being implemented in Machakos County in eastern province of Kenya.  It offers Risk-Contingent Credit (RCC), an innovative product for providing finance to households, particularly those that are quantity- or risk-rationed in access to credit.  The product embeds an index-based insurance product with a conventional credit product, thereby eliminating the need for borrowers to provide collateral as a condition for accessing credit. When triggered, the product offsets loan payments due to the lender. The triggering event is defined around measurable covariate risks of a catastrophic nature such as drought that affect crop yields. The underlying risk is captured through the development of a satellite-derived drought index that integrates environmental key variables (e.g. rainfall, vegetation and soil moisture) based on state-of-the-art remote sensors. The product has been rigorously developed and simulation exercises have demonstrated its effectiveness.

Evaluation design and methodology

The study employed a randomised control trial and behaviour experiments as well as mixed methods to identify the potential outcome variables. Around 1,150 households were randomly assigned to three groups: conventional credit, RCC and control group with no credit.  The authors undertook qualitative investigations including focus group discussions and informal interviews with households in selected sites. In addition, the study used quantitative methods to measure the magnitude of impacts on these outcomes and to verify the underlying mechanism.

Primary evaluation questions

1. Does the insurance feature of RCC encourages risk-rationed farmers to uptake loans?
2. Does uptake of RCC differs among farmers with different characteristics (such as risk preference)?
3. How does uptake of RCC affect farmers’ productive behavior and welfare?
4. How does the effects of RCC uptake differ from the effects of uptake of traditional loans?
5. Does the effect of RCC uptake differs among farmers with different characteristics?

Primary findings

1. Risk rationed households did not accept the offered loan because they were afraid of losing collateral.
2. There was an uptake of 80 per cent in the RCC loan group, compared to 20 per cent uptake of the traditional loan.
3. The average turn up for financial trainings was 71 per cent , with the highest being 91 per cent and lowest being 43 per cent.

Implications

1. This is study appears to be the first scientific bundling of rainfall-based index insurance and agricultural term loan through actuarially fair pricing.
2. The form of risk balancing offered by RCC  encourages supply and also stimulates credit use targeted towards more economically efficient input use at the intensive margin.